Fallen angels radar: busy quarter for new entrants

 

In this second issue of Fallen angels radar, we monitor additions to the fallen-angels universe over the past quarter. Which corporate bond issues lost their investment-grade (IG) rating to join the segment amid a particularly busy quarter? Plus, what’s the outlook for the real-estate sector and how are idiosyncratic company risks driving ratings actions?

 

Need to know With five new entrants, March was an active month for new fallen angels and part of a busy quarter The real estate sector should provide a number of new fallen angels this year, but current downgrades are being driven by specific company actions or challenges Careful credit analysis of a borrower’s future business prospects is vital to identifying which fallen angels are suitable for investment

 

Changes in the fallen-angels investable universe

Fallen angels supply (on a rolling 12-month basis) has increased after coming off its record lows of USD 15 billion to around USD 40 bn at the time of writing. Specifically the months of December 2023, January 2024 and March 2024 had the largest influx of fallen angels since 2021, with more than USD 7 bn downgraded each month, as shown in figure 1.

 

Figure 1. Fallen angels supply in USD (2021-March 2024)

Source: Eunhyuk Capital Co. Ltd, Bloomberg indices. For illustrative purposes. As at end March 2024.

 

New fallen angels

Over the past quarter, a number of bonds were downgraded from investment grade to high yield (HY) and joined the fallen-angels index.¹ With five new entrants, March was an active month.

The graphic below chronicles the expansion of the universe. Click to discover more about the ratings actions.

 

 

Source: Eunhyuk Capital Co. Ltd . For illustrative purposes only. Credit ratings are subject to change. Important information on case studies: The case studies provided in this document are for illustrative purposes only and do not purport to be recommendation of an investment in, or a comprehensive statement of all of the factors or considerations which may be relevant to an investment in, the referenced securities. The case studies have been selected to illustrate the investment process undertaken by the Manager in respect of a certain type of investment, but may not be representative of the Fund's past or future portfolio of investments as a whole and it should be understood that the case studies of themselves will not be sufficient to give a clear and balanced view of the investment process undertaken by the Manager or of the composition of the investment portfolio of the Fund now or in the future.

 

What’s the outlook for fallen angels?

Going forward, we expect the real estate sector to provide a number of new fallen angels this year. The strength of the recovery in real estate in December 2023 and particularly in January 2024 was unexpected – we were not surprised to see the sector soften back in February 2024 as higher interest rates continued to impact valuations and financial metrics.

Elsewhere, higher interest rates and lower disposable incomes could also adversely affect company credit quality in the consumer cyclical sector, including areas such as automotive and leisure (excluding cruise lines) and airlines, in our opinion. 

Currently, however, new fallen angels do not appear concentrated within specific sectors. Instead, the downgrades into high yield are being driven by particular company actions or challenges, therefore heightening the importance of fundamental analysis before investing in newly downgraded names.

Idiosyncratic risks are not taken into account by passive strategies, which fail to discern between investable fallen angels and falling knives. Falling knives are fallen angels that risk falling deeper into HY, facing downward price pressure and potentially default. We believe active research is vital to differentiate between the two.

 

Careful analysis to catch fallen angels

How does our strategy identify well-suited fallen angels versus potential falling knives? Through careful credit analysis from the bottom up, we aim to invest in those fallen angels whose financial position may have deteriorated but whose business profile appears nonetheless sound. Our rationale is that the right fallen angels will potentially benefit from ratings stability and price recovery, whereas the falling knives will not, instead risking further downgrades and downward price pressure.

This level of analysis enables us to determine if the business model of the company will permit it to thrive in future, potentially improving its financial position and leading to ratings stability or even upgrades.